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Chapter 2 Demand

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    • 1. Demand of Goods and Services
    • 2. Classification of Goods and Services
      • From conventional perspective
        • Free goods
        • Public goods
        • Economic goods
      • From Islamic perspectives
        • Al-tayyibat
        • Al-Rizq
    • 3. Conventional Perspectives
      • Free Good
      • Goods that have no production cost (air, sunlight, rain
      • water).
      • Public Goods
      • Goods that have a common use and are benefit to
      • everyone (public clinics, schools, hospital and others.)
      • Economic goods
      • Goods which supply is limited and require costs to
      • purchase them (books, clothes, houses, movies)
      • Price is involved in obtaining them.
    • 4. Islamic Perspective
      • Al-Tayyibat
      • Al-tayyibat means good things, clean and pure things, and sustenance of the best.
      • Bad goods are not considered as goods in Islam.
      • Al- Rizq
      • Al-rizq is used to denote the following meanings;
        • - Godly sustenance, godly provision and heavenly gifts
      • All these meanings denote that Allah s.w.t is the only sustainer and provider for all creatures.
    • 5. Hierarchy of needs
      • Dharuriyah
        • Goods that are classified as basic needs and necessary for a living. eg: food, cloth
      • Hajiyat
        • Goods that will improve the quality of human life eg: refrigerator, radio
      • Kamaliat
        • Goods that contribute towards the perfection of human life (luxury goods). Eg: bungalow house, Mercedes cars
      • Tarafiat
        • Not permissible (haram). Bring negative impact on society. Not only extravagant and wasteful, but also cause harm to man. Eg: liquor
    • 6. DEMAND OF GOODS AND SERVICES
    • 7. Definition of demand
      • The quantity of various goods that people are willing and able to buy at a particular time and at a given range of prices.
    • 8. DEMAND SCHEDULE AND DEMAND CURVE
      • Demand Schedule
        • The demand schedule is a table that shows the relationship between the price of the good and the quantity demanded
      • Demand Curve
        • A demand curve is a graphical representation of a demand schedule.
        • A graph of the relationship between the price of a good and the quantity demanded.
        • slopes downward and to the right.
    • 9. Figure 1 Siti’s Demand Schedule and Demand Curve Copyright © 2004 South-Western Price of Ice-Cream Cone 0 2.50 2.00 1.50 1.00 0.50 1 2 3 4 5 6 7 8 9 10 11 Quantity of Ice-Cream Cones $3.00 12 A B 1. A decrease in price ... 2. ... increases quantity of cones demanded.
    • 10. The Individual Demand Curve and the Law of Demand Demand Schedule for Pizza Price ($) Quantity of pizzas per month 2 13 4 10 6 7 8 4 10 1
    • 11. The Individual Demand Curve and the Law of Demand
      • The individual demand curve shows the relationship between the price of a good and the quantity that a single consumer is willing to buy, or quantity demanded.
      • The law of demand states that the higher the price, the smaller the quantity demanded, ceteris paribus (Other thing remain constant).
    • 12. WHY?
      • The Substitution Effect
      • consumers react to an increase in a good’s price by consuming less of that good and more of other goods.
      • The Income Effect
      • a person changes his or her consumption of goods and services as a result of a change in real income.
    • 13. Market Demand
      • Market demand is the sum of all the quantities of a good or service demanded per period by all the households buying in the market for that good or service.
    • 14.
      • From Individual Demand to Market Demand
      • market demand curve A curve showing the relationship between price and quantity demanded by all consumers, ceteris paribus.
      • Table 1.1 From Individual to Market Demand
    • 15. How to calculate market demand? Price Ind.1 Ind. 2 Market Demand RM 2.00 600 300 (600 + 300) = 900 RM 3.00 400 200 RM 4.00 200 100 RM 5.00 100 50
    • 16. Changes in Quantity Demanded 0 D Price of Ice-Cream Cones Quantity of Ice-Cream Cones A tax that raises the price of ice-cream cones results in a movement along the demand curve. A 8 1.00
      • Change in Quantity Demanded
        • Movement along the demand curve.
        • Caused by a change in the price of the product.
      B $2.00 4
    • 17. DEMAND SHIFTER
    • 18. SHIFTS IN THE DEMAND CURVE Tastes Income Number of buyers Expectations Prices of related goods ♥ Shift factors of demand are factors that cause shifts in the demand curve
    • 19. Shifts in the Demand Curve
      • Recall our assumption
        • hold other things constant – ceteris paribus allow only price to change
      • But what if other factors do change?
        • change in demand
        • shift to a new demand curve, either to the left or right.
        • alters the quantity demanded at every price.
    • 20. Figure 3 Shifts in the Demand Curve Copyright©2003 Southwestern/Thomson Learning Price of Ice-Cream Cone Quantity of Ice-Cream Cones 0 Increase in demand Decrease in demand Demand curve, D 3 Demand curve, D 1 Demand curve, D 2
    • 21. D 1 D 2 P QD 1 QD 2 Change in Income [Normal-Direct; Inferior-Inverse] More income results in more demand for new cars; less demand for used cars. New Cars Used Cars Less income results in more demand for used cars; less demand for new cars.
    • 22. The Impact of a Change in Income
      • Higher income decreases the demand for an inferior good
      • Higher income increases the demand for a normal good
    • 23. Change in Income
      • An increase in income will lead to an increase in demand for most goods & services because the amount of purchasing power increases, vice versa
      • As consumer’s income rises, the demand for higher quality goods will certainly increase (shown by the shift of dd curve to right)  normal good
      • Products for which demand declines as income rises  inferior good
    • 24. Complement [ Inverse ] Substitute [ Direct ] Milk Cereal Pop Tarts D 1 D 2 P P 1 QD 1 P 2 D 1 D 2 D P Prices of Related Goods [Substitutes-Direct; Complements-Inverse] QD 2
    • 25. Prices of Related Goods
      • Changes in the price of substitutes
          • Rise in prices of one good lead to a contraction in the quantity of the good demanded & increase in the demand for its substitutes
      • Changes in the price of complements
          • Goods that are consumed together. When demand for one good rises, so does demand for the other.
    • 26. D 1 D 2 P QD 1 QD 2 "Change in Taste" [Direct] An increase in taste for DVDs results in an increase in demand . A decrease in taste for videos results in a decrease in demand . D 3 QD 3
    • 27. D 1 D 2 P QD 1 QD 2 Expectations [of consumers] [about future price, availibility, & income] iPhone $399 Buy it now to save money.
    • 28. D 1 D 2 P QD 1 QD 2 Expectations [of consumers] [about future availibility of toilet tissue] If there is expected to be a major shortage of toilet tissue , then consumers will stock up now or risk not getting any.
    • 29. D 1 D 2 P QD 1 QD 2 Expectations [of consumers] [about future income] Let’s say that we are coming out of recession & consumers feel secure about their jobs. [ Positive future income ]
    • 30. D 1 D 2 P QD 1 QD 2 Expectations [of consumers] [about future income] Let’s say that we are going into a recession and consumers don’t feel secure about their jobs. [ Negative future income ]
    • 31. D 1 D 2 P QD 1 QD 2 Change in Market Size [Direct] [Number of Consumers] More demand for both normal & inferior goods New Cars Used Cars
    • 32. When price changes, what happens?
      • The curve does not shift.
      • There is a change in the quantity demanded
    • 33. $20 $15 $10 $5 10 20 30 40 A B A change in price causes a change in the quantity demanded D P Q 50
    • 34. When something changes other than price, what happens?
      • The whole curve shifts,there is a change in demand
    • 35. Change in Quantity Demanded vs. Change in Demand Change in quantity demanded Change in demand
      • Refer to a movement along a given demand curve
      • As a result of a change in the commodity price (price of the good itself whereas other factors influencing demand remains unchanged)
      • Refer to a shift in the demand curve (left / right)
      • As a result of a change in the economics variable and not the price of the good itself
    • 36. A Change in Demand Versus a Change in Quantity Demanded To summarize : Change in price of a good or service leads to Change in quantity demanded ( Movement along the curve ). Change in income, preferences, or prices of other goods or services leads to Change in demand ( Shift of curve ).
    • 37. The Exceptional Demand Curve
      • Normal dd curve is always downward sloping showing inverse relationship between price of a good and quantity demanded
      • However, there is a possibility that price increases, the quantity demanded also increases @ quantity demanded of a good decreases when its price falls
      • Divided into 2
          • Regressive at high prices
            • Happens to luxury goods like antique and jewellery items
            • Bought by the rich to show off their status
            • Higher price  more goods would be demanded
          • Regressive at low price
            • Happens to inferior goods like broken rice and salted fish
            • Lower the price offered, fewer would be demanded by the poor  substitute the existing goods to better quality goods
    • 38. Luxuries goods
      • Those products that have an income elasticity of demand greater than 1.
      • The more expensive the goods, the greater will be the demand.
      • Jewellery, antique furniture, picture of Mona Lisa etc
      Exceptional dd curve regressive at high price Q P d
    • 39. Exceptional Demand
      • Doesn't follow the law of demand
      • Giffen goods
        • The demand curve for giffen goods is normally upward sloping.
        • Purchasing power has increase, which allowed people to replace with better quality goods
      Exceptional dd curve regressive at low price P Q d
    • 40. ELASTICITY OF DEMAND
      • Definition:
      • Elasticity means responsiveness or sensitivity. Therefore elasticity of demand means the responsiveness of demand due to the changes of the factors that influence demand.
    • 41. Types of Elasticity:
      • Price elasticity of demand
      • Cross elasticity of demand
      • Income elasticity of demand
      • Price elasticity of supply
    • 42. i. Price Elasticity of Demand (Ed)
      • Ed measures the responsiveness of the quantity demanded due to the change in its price.
      • Ed tries to measure how much does demand has decreased when price increased
    • 43.
      • Calculating price elasticity of demand;
      • Formula:
      • Ed = ( % ∆ in Qd for product X)
      • % ∆ in P of product X
      • = % ∆ in Q
      • % ∆ in P
      • = ( ∆ Q) x P 0
      • Q 0 ∆P
      • = ( Q 1 – Q 0 ) x P 0
      • Q 0 (P 1 – P 0 )
    • 44.
      • Example:
      • Price(RM) Quantity Demanded
      • 2.00 10
      • 3.00 5
      • Calculate the price elasticity of demand when price increases from RM2.00 to RM3.00.
    • 45.
      • Ed = ∆ Q x P 0
      • Q 0 ∆ P
      • = ( Q 1 – Q 0 ) x P 0
      • Q 0 (P 1 – P 0 )
      • = ( 5 – 10 ) x 2
      • 10 (3 – 2)
      • = -1
      • # If price of good X increases by 1%, quantity of good X demanded will decrease by 1%
    • 46. Degrees of Price Elasticity of Demand
      • Elastic demand (Ed > 1)
      • Percentage change in quantity demanded is greater then the percentage change in price.
      • %Δ Q > %Δ P
      P Q D D Smooth line dd curve
    • 47. ii. Inelastic demand (0<Ed<1) or (Ed < 1)
      • Percentage change in quantity is less than the percentage change in price.
      • %Δ Q < %Δ P
      P Q D D Steep line dd curve
    • 48. iii. Unitary elastic (Ed = 1)
      • Percentage change in quantity demanded is equal to the percentage change in price.
      • %Δ Q = %Δ P
      D P X Hyperbola line dd curve
    • 49. iv. Perfectly Elastic (Ed = ∞)
      • Percentage change in quantity demanded is infinite in relation to the percentage change in price  small % change in price of a good would lead to infinite changes in its quantity demanded
      P Q D P 0 Horizontal line demand curve
    • 50. v. Perfectly Inelastic (Ed = 0 )
      • Quantity demanded does not change as the price changes.
      P Q Q 0 D P 1 P 2
    • 51. Determinants of Price Elasticity of Demand
      • Availability of substitutes
      • many substitutes  more elastic dd
      • less/no substitutes  less elactic/ inelastic dd
      • Eg: petrol and detergents (liquid, soap)
      • Relative importance of the goods in the budget
      • greater the income spent  more elastic dd
      • Eg: dd for house is more elastic compared to demand for detergents because money spent on houses is greater than money spent on detergents.
    • 52.
      • Time frame
      • In short run  less elastic/ inelastic dd
      • In the long run demand  more elastic because consumers can make adjustment and find other substitutes.
      • The importance of goods – necessity or luxury
      • Necessity good  inelastic dd
      • eg: rice (great increase in price will not reduce the demand for rice very much).
      • Luxury goods/ less important goods  elastic dd
      • The number of usage
        • many number of usage  more elastic compared to goods that have fewer usage. Eg: demand for rubber is more elastic because it can be processed into rubber hoses, tyres, gloves, & etc
    • 53.
      • Income level
      • higher income people  inelastic dd.
      • lower income group  elastic dd (sensitive to price changes)
      • Habits
      • habits  inelastic dd.
      • Eg: demand for cigarette by smokers.
    • 54. Relationship between price elasticity of demand and total revenue (TR)
      • Important for producers to decide whether they should increase, decrease or maintain the price of the good they sold in the market to enable them to maximize their profit
      • TR = price x quantity
      • TR increases or decreases when there is price changes depend on the price elasticity of demand.
      • i. If demand is elastic, to increase TR, price should be decreased.
      • ii. If demand is inelastic, to increase TR, price should be increased.
      • iii. If demand is unitary elastic, change in price would not affect and change in TR.
    • 55. (i) Inelastic demand (Ed<1) Assume price increases from RM10 to RM15 Price (RM) Quantity (units) 8 10 10 15 Steep line demand curve TR before = RM10 x 10 = RM100 TR after = RM15 x 8 = RM120 (TR increases) # If demand is inelastic, an increase in price will lead to an increase total revenue & vice versa
    • 56. ii) Elastic demand (Ed>1) Assume that price increases from Rm10 to RM11 Smooth line demand curve P Q 7 10 10 11 TR before = RM10 x 10 = RM100 TR after = RM11 x 7 = RM77 (TR decreases) # If demand is elastic, an increase in price will lead to a decrease in total revenue.
    • 57. iii) Unitary elastic demand (Ed=1) Assume that price increases from RM10 to RM20 20 10 10 20 P Q TR before = RM10 x 20 = RM200 TR after = RM20 x 10 = RM200 (TR remains the same) # If demand is unitary elastic, an increase in price will make total revenue remains the same Hyperbola line dd curve
    • 58. The R/ship between TR & Price Elasticity of Demand when Price Increases Elasticity Coefficient Price Elasticity of Demand Price Quantity Demanded Total Revenue Ed>1 Elastic Increases Decreases more than proportionate Decreases Ed=1 Unitary elastic Increases Decreases in exact proportion Remain the same Ed<1 Inelastic Increases Decreases less than proportionate Increases
    • 59. The R/ship between TR & Price Elasticity of Demand when Price Decreases Elasticity Coefficient Price Elasticity of Demand Price Quantity Demanded Total Revenue Ed>1 Elastic Decreases Increases more than proportionate Increases Ed=1 Unitary elastic Decreases Increases in exact proportion Remain the same Ed<1 Inelastic Decreases Increases less than proportionate Decreases
    • 60. Cross Elasticity of Demand (Exy)
      • Exy measures the responsiveness of quantity demanded for one product to a change in the price of another product.
      • Formula:
      • Exy = % ∆ in Qx
      • % ∆ in Py
      • = ∆ Qx x Py 0
      • ∆ Py Qx 0
      • = ( Qx 1 – Qx 0 ) x Py 0
      • (Py 1 – Py 0 ) Qx 0
    • 61.
      • Exy < 0  product X is a complement of product Y
      • Exy > 0  product X and Y are substitutes for one another
      • Exy = 0  product X and Y are independent for one another
    • 62.
      • Example:
      • Price of Y Quantity x Quantity Y
      • RM10 60 15
      • RM18 40 25
      • RM25 20 30
      • Calculate the cross elasticity of demand for good x when the price of y increases from RM18 to RM25
    • 63.
      • Answer:
      • Formula :
      • = ∆ Qx x Py 0
      • ∆ Py Qx 0
      • = ( Qx 1 – Qx 0 ) x Py 0
      • Qx 0 Py 1 – Py 0
      • = 20 - 40 x 18
      • 40 25 - 18
      • = -1.29
      • Conclusion;
      • Goods x and y are complement
    • 64. Income Elasticity of Demand (Ey)
      • Ey measures the responsiveness of quantity demanded to a change in income.
      • Three possibilities:
      • i. If Ey is positive = normal goods -
      • Ey >1 - luxury
      • Ey ≤ 1 – necessity
      • ii. If Ey is negative = inferior goods
      • iii. If Ey is zero = essential goods
      • Eg. Ey = 5  if income increase 1%, quant. demanded for good X will increase by 5%
      • Ey = 0  if income changes, quant. demanded for good B remains unchanged
    • 65.
      • Formula:
      • Ey = % ∆ in Q
      • % ∆ in Y
      • = ∆ Q x Y 0
      • ∆ Y Q 0
      • = ( Q 1 – Q 0 ) x Y 0
      • (Y 1 – Y 0 ) Q 0
      • = (Q 1 – Q 0 ) x Y 0
      • Q 0 (Y 1 – Y 0 )
    • 66.
      • Example:
      • Income Qty A Qty B Qty C
      • 100 10 20 20
      • 120 15 20 18
      • 150 17 20 14
      • Calculate the income elasticity of demand for goods A, B and C when income increases from RM120 to RM150.
    • 67.
      • Good A :
      • Ey = ( QA 1 – QA 0 ) x Y 0
      • QA 0 (Y 1 – Y 0 )
      • = (17 – 15) x 120
      • 15 (150 – 120)
      • = 0.53
      • Since Ey is positive and < 1, good A is a necessity good
      • When Y increase by 1%, quant. demanded for good A increase by 0.53%
    • 68.
      • Good B :
      • Ey = ( QB 1 – QB 0 ) x Y 0
      • QB 0 (Y 1 – Y 0 )
      • = (20 – 20) x 120
      • 20 (150 – 120)
      • = 0 (Good B is essential good)
      • # if Y change, q.demanded for good B remains unchanged
    • 69.
      • Good C:
      • Ey = ( QC 1 – QC 0 ) x Y 0
      • QC 0 (Y 1 – Y 0 )
      • = (14 – 18) x 120 18 (150 – 120)
      • = - 0.89
      • Good C is an inferior good
      • When Y increase by 1%, quantity demanded for good C decrease by 0.89%